Lions Gate Entertainment Corp (NYSE:LGF-A) is an independent publicly traded film and television production studio. Its relatively small market cap (less than $6 billion) and its breadth of operations -- film and television production, equity stake in premium movie channels, video on demand, and an expanding international distribution footprint through wholly owned subsidiaries and partnerships -- make it one of my favorite risk-reward investments in the space.
It is a content-production machine that I think is poised to be a market-beating stock. Let's take a closer look.
Major tentpole films and low-budget safe returns
The company's largest financial success has been the four-part big-screen Hunger Games series. The first three films have already generated a combined $2.3 billion in worldwide gross sales, and the fourth is scheduled to be released in November. The combined gross for the series should top $3 billion.
Lions Gate stock was trading under $10 per share in January 2012, a few months before the first Hunger Games film came out. Now it's up to nearly $40, and the Hunger Games films have been a major factor.
All good things must come to an end, though, and Lions Gate will need to replace this source of revenue. While not as successful as the previous cash cow, the Divergent series of films have delivered nearly $600 million in sales over the first two films, with two more still to come.
The good news is that Lions Gate isn't a one-trick pony that turns wildly popular young adult fiction into wildly popular four-part movie franchises. It also focuses on inexpensive, relatively formulaic, and usually horror-based films that help create consistent sales.
My Bloody Valentine 3-D from 2009, for example, had a production budget of only $15 million and generated over $100 million in worldwide sales. And Sinister from 2012 was made on a $3 million budget and grossed $77 million worldwide. These types of movies are low-risk, won't lead to massive writedowns for the company, and can sometimes become smash hits.
These films, along with a series of Tyler Perry movies, help insulate Lions Gate from the boom-and-bust cycle of a studio that may only put out a handful of big-budget movies in a given year. This advantage should give investors some peace of mind when investing in Lions Gate for the long haul.
Lions Gate's television business consists of 28 shows on 20 different networks. These include traditional channels like ABC, premium channels such as Showtime, and non-linear streaming sites such as Netflix and Hulu. Wherever the future of television is heading, great content will still be required. Lions Gate is not wedded to one company or means of transmission and this should benefit it in the long run.
Lions Gate makes money on the shows it produces in different ways, depending on its partner. According to a Variety piece from 2013, Netflix was paying an Orange Is the New Black production budget of around $4 million per episode and retained a four-year exclusivity window. After that window expires Lions Gate would be able to sell the series to another content distribution company -- either linear television or another streaming site. For a hit show, this potential payoff can be huge.
A so-called 10+90 television series model was, according to the company, "pioneered by Lionsgate's Debmar-Mercury syndication company and results in generally higher margins based on an accelerated path to syndication." In this model, a company like FX orders 10 episodes of a new show with the option to immediately purchase 90 more. One hundred episodes is the generally accepted minimum number of shows for a series to be eligible for syndication.
Charlie Sheen's Anger Management is one such 10+90 series that has proven to be fruitful for Lions Gate. According to a company media release, "100 episodes of Anger Management sold in dozens of international territories for more than $800,000 an episode."
The company's most critically acclaimed show ever, Mad Men, recently finished its final season and should find continued life through syndication.
According to a company press release about FY 2015 results, television production revenue rose to an all-time high of $579.5 million, up 30% over the prior year. In addition, "A record 238 episodes and 168 hours of domestic television series were delivered in the fiscal year, including episodes of Anger Management, Orange Is the New Black, Nashville, Mad Men, Manhattan, The Royals, and Nurse Jackie. The fiscal year also benefited from significant domestic television revenue from the talk and game shows The Wendy Williams Show and Family Feud."
According to Variety, Family Feud recently rose to the No. 1 spot on the syndication chart for the first time, narrowly beating longtime stalwarts Wheel of Fortune and Jeopardy! to take the top spot.
The channel experience
Lions Gate owns a stake in a handful of branded channels worldwide, with Epix being the most prominent. Epix currently has over 10 million subscribers and is reportedly available to more than 50 million homes. After being started as a joint partnership in 2009 with Viacom and MGM, the channel has a long way to go to catch up to HBO's 31+ million subscribers or even Starz or Showtime at around 23 million a piece.
LGF's equity position in Epix and eight other branded channels around the world provide the company with the means to further monetize its portfolio of movies and television shows. Recently Epix announced that it would be getting directly into scripted television itself with two original series, a half-hour comedy and an hour-long spy drama.
Potential takeout target, and a small yield
Holding shares in a company just because you think it might be acquired is a bad investing strategy. I'd love to see Lions Gate remain independent, continue to successfully execute, and eventually become a serious competitor to the biggest film and television studios in the world. But with its wonderful properties and relatively small market cap, I wouldn't be shocked if a larger company, either in the space or one looking to get into content generation, decided to gobble it up. If so, a buyout would likely come at a nice premium to where shares currently trade.
Lions Gate has always acted like a bigger company than it really is, and its dividend policy is no exception. It began a small payout in late 2013 and has raised the dividend once since. With the stock near all-time highs, the yield is under 1%, but there will almost certainly be raises in the future. Its trailing-12-month payout ratio is extremely conservative at 21.7%, which means that a doubling or even tripling of the current payout could easily be covered by current earnings. Dividends, of course, provide some downside protection for the individual investor.
If you've ever fancied yourself to be a movie mogul, or just an investor looking to buy great companies and hold them for a long time, you could do worse than looking to pick up some shares in Lions Gate.
James Sullivan owns shares of Lions Gate Entertainment and Walt Disney. The Motley Fool recommends Lions Gate Entertainment and Walt Disney. The Motley Fool owns shares of Lions Gate Entertainment and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.